NO. C15-1701-1
IN THE
SUPREME COURT OF THE UNITED
STATES OF AMERICA
ROYAL HARKONNEN OIL COMPANY,
PETITIONER,
v.
UNITED STATES,
RESPONDENT.
ON WRIT OF CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE FOURTEENTH CIRCUIT
BRIEF FOR PETITIONER
TEAM # 56
COUNSEL FOR PETITIONER
STATEMENT OF THE ISSUES
1.
Whether the Republic of Arrakis Foreign Tax (“RAFT”) formula sufficiently
reached the Royal Harkonnen Oil Company’s (“Harkonnen”) net income when
the tax allowed 95% of all deductions to offset the company’s costs and
expenses.
2.
Whether the Inter-Sietch Fremen Independence League (“the League”)
properly levied taxes when the League was determined to be a part of
Arrakis, and whether Harkonnen exhausted all effective and practical
remedies when the Holy Royal Court made a final decision on Harkonnen’s
tax liability.
ii
TABLE OF CONTENTS
Page(s)
STATEMENT OF THE ISSUES ................................................................................... ii
TABLE OF AUTHORITIES .......................................................................................... v
OPINIONS BELOW ...................................................................................................... 1
STATUTORY PROVISIONS ......................................................................................... 1
STATEMENT OF JURISDICTION .............................................................................. 1
STATEMENT OF THE CASE ....................................................................................... 2
SUMMARY OF THE ARGUMENT .............................................................................. 9
ARGUMENT ................................................................................................................ 12
I.
The RAFT qualifies as a foreign tax credit under § 901 when it is
formulated, in substance, to be compulsory and its effect
sufficiently reaches net gain .................................................................. 13
A. The dual capacity taxpayer status is inapplicable where the
RAFT is generally imposed on all foreign entities regardless
of the foreign entities’ business operations in Arrakis .................... 13
B. The Arrakis Constitution empowers the Arrakis Central
Bank a confiscatory withholding of all foreign entities’ gross
receipts, and deducting applicable taxes before returning the
net gain to such foreign entities ....................................................... 15
C. Under the Regulations, the RAFT satisfies all three parts of
the predominant character test ........................................................ 18
1. The RAFT is designed to impose tax liability upon or
subsequent to the realization of gross receipts .................. 19
2. The RAFT bases liability upon a foreign entity’s
gross receipts ....................................................................... 20
3. President Corrino’s Proclamation 102 allows all
foreign entities to recover a significant portion of
costs and expenses ............................................................... 21
iii
D. Alternatively, the RAFT’s structure qualifies as a tax in lieu
of a generally imposed domestic tax ................................................ 26
II.
The laws of Arrakis recognize the sovereignty of the League,
which in turn may exact taxes upon citizens and entities within
its territory ............................................................................................. 27
A.
The Holy Royal Court, neighboring countries, and the
United States per Executive Order 14012 have recognized
the League as a sovereign entity capable of levying taxes ........ 28
B.
Harkonnen exhausted all effective and practical remedies
by petitioning the Holy Royal Court for a resolution on its
taxes to the League ...................................................................... 33
CONCLUSION............................................................................................................. 36
APPENDICES
APPENDIX A: I.R.C. § 901 (2012) ............................................................................... A-1
APPENDIX B: Treas. Reg. § 1.901-2 (2013) ..................................................................B-1
APPENDIX C: Treas. Reg. § 1.901-2A (1983) ...............................................................C-1
APPENDIX D: I.R.C. § 903 (2012) ............................................................................... D-1
APPENDIX E: Treas. Reg. § 1.903-1 (1983) .................................................................. E-1
iv
TABLE OF AUTHORITIES
Page(s)
United States Court Cases
Am. Chicle Co. v. United States,
316 U.S. 450 (1942) .................................................................................................. 12
Amoco Corp. v. Comm'r.,
138 F.3d 1139 (7th Cir. 1998) .................................................................................. 16
Bank of Am. Nat’l Trust & Savs. Ass’n v. United States,
459 F.2d 513 (Ct. Cl. 1972) ...................................................................................... 21
Biddle v. Comm'r,
302 U.S. 573 (1938) .................................................................................................. 18
Burnet v. Chi. Portrait Co.,
285 U.S. 1 (1932) .......................................................................................... 28, 29, 30
Cesarini v. United States,
428 F.2d 812 (6th Cir. 1970) .................................................................................... 19
Comm'r v. Am. Metal Co.,
221 F.2d 134 (2d Cir. 1955) ...................................................................................... 21
Comm'r v. Glenshaw Glass Co.,
348 U.S. 426 (1955) .................................................................................................. 19
Cox v. Comm'r,
41 T.C. 161 (1963) .................................................................................................... 16
Entergy Corp. & Affiliated Subsidiaries v. Comm'r,
683 F.3d 233 (5th Cir. 2012) .................................................................................... 18
Exxon Corp. v. Comm'r,
113 T.C. 338 (1999) ...................................................................................... 21, 22, 23
Harris v. United States,
19 F.3d 1090 (5th Cir. 1994) .................................................................................... 29
Helvering v. Bruun,
309 U.S. 461 (1940) .................................................................................................. 19
v
Inland Steel Co. v. United States,
677 F.2d 72 (Ct. Cl. 1982) .................................................................................. 12, 18
IBM v. United States,
38 Fed. Cl. 661 (1997) .................................................................................. 15, 34, 35
Phillips Petroleum Co. v. Comm'r,
104 T.C. 256 (1995) .................................................................................................. 16
PPL Corp. v. Comm'r,
133 S. Ct. 1897 (2013) .............................................................................................. 18
Proctor & Gamble Co. v. United States,
No. 1:08-cv-00608, 2010 WL 2925099 (S.D. Ohio, July 6, 2010) ............................ 15
Riggs Nat’l Corp. & Subsidiaries v. Comm'r,
163 F.3d 1363 (D.C. Cir. 1999) .................................................................... 16, 17, 36
Santa Eulalia Mining Co. v. Comm'r,
2 T.C. 241 (1943) ...................................................................................................... 21
Texasgulf, Inc. & Subsidiaries v. Comm'r,
172 F.3d 209 (2d Cir. 1999) ................................................................................ 22, 24
United States v. Borja,
191 F. Supp. 563 (D. Guam. 1961)........................................................................... 29
United States v. Goodyear Tire & Rubber Co.,
493 U.S. 132 (1989) .................................................................................................. 12
W.S. Kirkpatrick & Co. v. Envtl. Tectonics Corp.,
493 U.S. 400 (1990) .................................................................................................. 17
Session Law
Revenue Act of 1918, ch. 18, 40 Stat. 1057 ................................................................. 12
Statutes
I.R.C. § 901 (2012) ................................................................................................passim
I.R.C. § 901(c) (2012) ................................................................................................... 35
I.R.C. § 901(j)(2) (2012) ................................................................................................ 29
vi
I.R.C. § 901(j)(2)(A)(iv) (2012) ..................................................................................... 32
I.R.C. § 901(j)(5) (2012) ................................................................................................ 29
I.R.C. § 901(j)(5)(B) (2012) ........................................................................................... 29
I.R.C. § 903 (2012) ................................................................................................passim
I.R.C. § 904 (2012) ....................................................................................................... 12
I.R.C. § 907 (2012) ....................................................................................................... 12
I.R.C. § 7803(a)(1)(D) (2012)........................................................................................ 29
28 U.S.C. § 1254(1) (2012) ............................................................................................. 1
Treasury Regulations
Treas. Reg. § 1.1001-1(a) (2007) .................................................................................. 19
Treas. Reg. § 1.901-2(a)(1) (2013).......................................................................... 14, 15
Treas. Reg. § 1.901-2(a)(1)(ii) (2013) ........................................................................... 18
Treas. Reg. § 1.901-2(a)(2) (2013).......................................................................... 15, 26
Treas. Reg. § 1.901-2(a)(2)(i) (2013) ...................................................................... 13, 28
Treas. Reg. § 1.901-2(a)(2)(ii)(B) (2013) ...................................................................... 13
Treas. Reg. § 1.901-2(a)(3)(i) (2013) ............................................................................ 18
Treas. Reg. § 1.901-2(b)(1) (2013)................................................................................ 18
Treas. Reg. § 1.901-2(b)(2)(i)(A) (2013) ....................................................................... 19
Treas. Reg. § 1.901-2(b)(2)(i)(B) (2013) ....................................................................... 19
Treas. Reg. § 1.901-2(b)(2)(i)(C) (2013) ....................................................................... 19
Treas. Reg. § 1.901-2(b)(3)(i) (2013) ............................................................................ 20
Treas. Reg. § 1.901-2(b)(4)(i)(A) (2013) ................................................................. 21, 25
Treas. Reg. § 1.901-2(b)(4)(i)(B) (2013) ................................................................. 21, 25
Treas. Reg. § 1.901-2(e)(5)(i) (2013) ............................................................................ 34
vii
Treas. Reg. § 1.901-2(g)(2) (2013)................................................................................ 28
Treas. Reg. § 1.901-2A(a)(1) (1983) ............................................................................. 14
Treas. Reg. § 1.901-2A(a)(2) (1983) ............................................................................. 14
Treas. Reg. § 1.903-1(a) (1983) .................................................................................... 26
Treas. Reg. § 1.903-1(b)(2) (1983)................................................................................ 25
Treas. Reg. § 1.903-1(b)(3) (1983)................................................................................ 26
Secondary Sources
Bittker & Lokken, Federal Taxation of Income, Estates & Gifts ¶
72.4.3 (2011) ............................................................................................................. 19
Frank Herbert, Dune (1965)........................................................................................ 33
Internal Rev. Serv., Publication 514, Foreign Tax Credit for
Individuals 6 (Jan. 14, 2014), available at http://www.irs.gov/pub/irspdf/p514.pdf ........................................................................................................ 28, 29
Rev. Rul. 2005-3, 2005-1 C.B. 334............................................................................... 29
Rev. Rul. 70-290, 1970-1 C.B. 160............................................................................... 35
viii
OPINIONS BELOW
The opinion of the United States District Court for the Central District of
New Tejas is unreported. The unreported opinion of the United States Court of
Appeals for the Fourteenth Circuit appears in the record at pages 2-21.
STATUTORY PROVISIONS
This case involves the application of I.R.C. § 901 (2012), which provides in
pertinent part: “[T]he following amounts shall be allowed as the credit under
subsection (a) . . . [i]n the case of a . . . domestic corporation, the amount of any
income, war profits, and excess profits taxes paid or accrued during the taxable year
to any foreign country . . . .” See Appendix A.
This case also involves the application of I.R.C. § 903 (2012), which provides
that the terms “income, war profits, and excess profits taxes shall include a tax paid
in lieu of a tax on income, war profits, or excess profits otherwise generally imposed
by any foreign country . . . .” See Appendix D.
STATEMENT OF JURISDICTION
This case is a petition from a judgment ordered by the United States Court of
Appeals for the Fourteenth Circuit. R. at 19. The Supreme Court of the United
States granted the petition for a writ of certiorari in the October 2014 Term. R. at
1. This Court has jurisdiction pursuant to 28 U.S.C. § 1254(1) (2012).
1
STATEMENT OF THE CASE
I.
Factual Background
A.
The Royal Harkonnen Oil Company (“Harkonnen”)
Harkonnen is a U.S. based company, seeking to expand its foreign presence
in the Republic of Arrakis (“Arrakis”). R. at 2. In March 2007, Harkonnen began
conducting seismic and feasibility studies on the Caladan Oil Field (“Caladan
Field”) of Arrakis. R. at 2. Upon completion, Harkonnen concluded that the
Caladan Field covered an area of 231,000 square miles and contained
approximately 150B barrels of oil equivalents. R. at 3. Harkonnen was interested
in the Caladan Field but not without reservations. R. at 3. Harkonnen reasoned
that if Arrakis’ demands outweighed the benefits from the use of the Caladan Field,
then Harkonnen would abandon its potential activities in the Caladan Field. R. at
3. After several months of negotiations, Harkonnen and Arrakis signed a lease
(“Arrakis Lease”) granting Harkonnen exclusive rights to develop on the Caladan
Field. R. at 7. The lease required Harkonnen to pay a one-time payment of $55M
and an annual royalty of 15%. R. at 7.
In 2010, Harkonnen signed a lease with the Sietch State (“Sietch Lease”),
granting the company rights to conduct its oil activities within the Sietch State. R.
at 10. The lease required Harkonnen to pay a one-time payment of $5M and an
annual royalty of 5%. R. at 10.
In 2011, Harkonnen signed a lease with the League (“League Lease”),
granting the company rights to operate within the League’s territory. R. at 13. The
2
lease required Harkonnen to pay a one-time payment of $550k and an annual
royalty of 5%. R. at 13. In addition, the League imposed a 2% tax on Harkonnen as
a condition of carrying on its business. R. at 13. In 2011, Harkonnen paid all
required taxes to Arrakis, the Sietch State, and the League. R. at 16. It then
timely filed its tax forms in 2012, and claimed foreign tax credits against its taxes
paid. R. at 16.
B.
The Republic of Arrakis
Arrakis is a country built on two contrasting religions. R. at 4, 16 n.14. On
one hand, there is the Arrakis Throne, and on the other, the Sietch Throne. R. at 3
n.4. The two thrones have existed since 439 A.D. R. at 16 n.14. They have
frequently engaged in military conflicts, but in 1864, the two thrones engaged in a
final war known as the “Bloody Ten Year War,” which resulted in a victory for the
Arrakis Throne. R. at 3 n.4. Following the resolution of the war, the Arrakis
Throne claimed dominance over the entire land. R. at 3 n.4. Presently, President
Jules Corrino (“President Corrino”) is the sitting President of Arrakis. R. at 3.
President Corrino holds his position for life. R. at 3.
Since the Bloody Ten Year War, the Sietch Throne continues to forge
rebellions across the country. R. at 5-6, 8, 11. The first rebellion took place in April
2008, where the Sietch Throne began an uprising in the Sietch Dunes region
(“Sietch Dunes”) of Arrakis. R. at 5. The intent was to declare independence for the
people residing in the Sietch Dunes. R. at 6. President Corrino dispatched the
3
military to quell the rebellion. R. at 6. In May 2008, the rebellion was subdued and
President Corrino withdrew the military. R. at 7.
The second rebellion took place in March 2010. R. at 8. This time, a group
calling themselves the Independent People of Sietch (“IPS”) declared independence
for the region. President Corrino again mobilized the military to quell the rebellion.
R. at 8. After less than one month of fighting, both sides suffered heavy
casualties—the IPS more so than Arrakis. R. at 8. In response, the United States
designated Arrakis as a “Dangerous State,” which was later undesignated by the
U.S. State Department. R. at 8, 10. In early April 2010, President Corrino, the IPS
leader Paul Atreides (“Atreides”), the U.S. Ambassador, and Harkonnen met at the
Arrakeen Peace Summit to resolve the military conflict. R. at 8. Ultimately,
Arrakis and IPS reached a truce and executed the Sietch Dunes Peace Treaty
(“Peace Treaty”). R. at 8.
The Peace Treaty contained a number of provisions: First, the Sietch Dunes
would become an independent province of Arrakis—the Sietch State. R. at 8.
Second, the Sietch State elects a vice president who would serve in President
Corrino’s cabinet. R. at 8-9. Third, the IPS becomes a political party of the Sietch
State. R. at 9. Fourth, the Sietch State would send monetary tribute to Arrakis. R.
at 9. Finally, the Sietch State vowed to never seek independence again. R. at 9
(emphasis added).
To give effect to the Peace Treaty, President Corrino amended the Arrakis
Constitution to create a vice president position for the Sietch State. R. at 9. As a
4
part of the amendment, the Vice President is tasked with upholding the provisions
of the Peace Treaty. R. at 9. Among those provisions, the Vice President can create
and enforce laws within the Sietch State such as police powers and collection tribute
for Arrakis. R. at 9. The Vice President may also appoint ten individuals to form a
Sietch Council (the “Council”). R. at 9. The Council conducted all judicial functions
within the Sietch State. R. at 9. The Vice President could decree and levy a single
tax but may only amend it with the approval of President Corrino. R. at 9. Lastly,
President Corrino must accept all suggested policies of the Vice President before
they become law. R. at 9. On April 2010, Atreides was elected as the Vice
President of the Sietch State. R. at 9.
The third rebellion took place in December 2010. R. at 11. A group calling
themselves the Inter-Sietch Fremen Independence League (the “League”) launched
a rebellion against Arrakis and the Sietch State. R. at 11. This rebellion was led by
the League’s leader, Jessica Mohiam (“Mohiam”). R. at 11. Mohiam was born into a
terrorist organization known as the Bene Gesserit. R. at 11. At the age of eighteen,
however, Mohiam rejected the organization as “an archaic organization with
fundamentalist beliefs that have no place in a modern world.” R. at 11. The
League’s purpose was to liberate and promote economic opportunities for all
Sietchians within Arrakis. R. at 12. The League’s political structure consisted of an
annual election of a single Leader Elect. R. at 12. Mohiam has won unanimously
each year since 2008. R. at 12.
5
In 2011, Al Dhanab, Anbus, France, and Russia all declared the League as a
legitimate government. R. at 12-13. Shortly following this designation, the
President of the United States issued Executive Order 14012, proclaiming that the
League is “a sovereign friend of the United States, [with] whom we would like to
establish trade relations [].” R. at 14. Also, Arrakis’ Holy Royal Court recognized
the League as a part of Sietch. R. at 14.
1.
Arrakis’ Tax Structure
Arrakis’ tax structure is largely based on religious norms. R. at 4.
Historically, the Arrakis tax structure only applied to Arrakis citizens. R. at 4.
Foreign citizens and entities were not liable for taxes. R. at 4. However, as an
attempt to comport with modern tax law, President Corrino signed into law a new
tax that established liability upon foreign entities operating within Arrakis. R. at 5.
The tax, initially labeled as the Republic of Arrakis Foreign Value Tax (“RAFVT”),
but was later renamed as the Republic of Arrakis Foreign Tax (“RAFT”). R. at 5, 7.
The RAFVT was formulated as: gross receipts multiplied by the tax rate (T = GR x
0.45). R. at 5, 7. In contrast, the RAFT is formulated as: gross receipts less
applicable deductions multiplied by the tax rate (T = (GR – D) x 0.33). R. at 5, 7, 15.
The only limitation is that foreign entities are capped at 95% of applicable
deductions. R. at 15.
2.
The Sietch State’s Tax Structure
Upon the amendment to the Arrakis Constitution, Vice President Atreides
decreed and levied a tax for the Sietch State. R. at 9. The Sietch State’s tax
6
structure is nearly identical to the RAFT: total income less applicable deductions
multiplied by the tax rate (T = (I – D) x 0.10). R. at 10. The only difference lies in
the applicable deductions: a 100% deduction for the Sietch State versus the RAFT’s
95% limitation.
3.
The League’s Tax Structure
The League’s tax structure is just as simple as the RAFT and Sietch State’s
formulas: gross receipts less applicable deductions multiplied by the tax rate (T =
(GR – D) x 0.02). R. at 13. The deductions allowed are identical to those of the
Sietch State.
II.
Procedural History
In 2012, the Commissioner of the Internal Revenue Service (“Commissioner”
or “IRS”) disallowed Harkonnen’s foreign tax credit for taxes paid to Arrakis and
the League. R. at 16-17. However, the IRS allowed a foreign tax credit for taxes
paid to the Sietch State. R. at 17. Harkonnen then filed for a refund of foreign tax
credits in the United States District Court for the Central District of New Tejas,
and the court ruled in favor of the IRS. R. at 17.
On appeal, the Fourteenth Circuit affirmed the district court’s decision. R. at
19. The circuit court held that the RAFT did not sufficiently reach net income,
failing the predominant character test set out in the Treasury Regulations
(“Regulations”). The circuit court found that the RAFT did not afford a recovery of
significant costs and expenses. R. at 17. The circuit court further held that the
League was not a legitimate taxing authority, dismissing the effect of the Executive
7
Order 14012 and a ruling from the Holy Royal Court. R. at 18. The circuit court
labeled the League as a subservient entity within the Sietch State to which the
provisions of the Peace Treaty applied. R. at 18. As such, the League’s tax is a
“second” tax that violated the Peace Treaty. R. at 18. Additionally, the circuit court
reasoned that Harkonnen’s failure to petition the Council on matters regarding
taxes failed the exhaustion of remedies requirement. R. at 18.
Harkonnen subsequently petitioned this Court for a writ of certiorari, which
this Court granted. R. at 1.
8
SUMMARY OF THE ARGUMENT
This Court should reverse the decision of the Fourteenth Circuit concerning
the RAFT because in substance, the formula adequately and sufficiently reaches net
income despite the 95% limitation. This Court should also reverse the Fourteenth
Circuit’s decision concerning the League’s authority to exact taxes because the
League is a legitimate government of Arrakis. Moreover, Harkonnen exhausted all
effective and practical remedies when it sought a decision from the Holy Royal
Court.
The first issue involves whether the RAFT qualifies as a foreign tax credit.
The Commissioner contends that the RAFT does not satisfy the tests under I.R.C.
§§ 901, 903 (2012), and therefore, does not qualify as a foreign tax credit.
To qualify as a foreign tax credit, the foreign levy must be (1) a tax and (2)
satisfy the predominant character test when interpreted in the U.S. sense. The
RAFT is a tax because the Arrakis Constitution authorizes it and is enforced by the
President of Arrakis. Additionally, the RAFT satisfies the predominant character
test, which contains three elements: (1) that the RAFT is imposed prior to, upon, or
subsequent to a realization event; (2) that the RAFT is based on gross receipts; and
(3) that the RAFT reaches net income by allowing sufficient deductions against a
company’s costs and expenses. The RAFT satisfies all three elements.
First, the RAFT is imposed upon or subsequent to a realization event because
Arrakis withheld taxes that applied to Harkonnen’s gross receipts. Gross receipts
occur when Harkonnen exchanges its barrels of oil on the market. Second, the
9
RAFT is on the based tax liability of gross receipts. Third, the RAFT is formulated
in such a way that foreign entities are allowed 95% of recovery for costs and
expenses. The 5% of non-recoverable costs and expenses had little to no effect on
the calculation of net income. The 95% limitation, when compared to a maximum of
100%, has a potential effect of less than 1% on actual non-recoverable costs and
expenses. Moreover, the Regulations require a foreign levy to allow for the recovery
of significant costs and expenses. The 5% difference is insignificant in the recovery
calculation. Therefore, the RAFT, in substance, satisfies the predominant character
test and qualifies as a valid foreign tax credit.
Alternatively, the RAFT qualifies as a foreign tax credit under I.R.C. § 903
(2012) because the RAFT is also a tax in lieu of a generally imposed tax. Under the
Arrakis tax structure, domestic citizens and entities are taxed and afforded full
deductions. Conversely, the RAFT applies only to foreign entities operating in
Arrakis. The RAFT also applies equally to all foreign taxpayers, and therefore, was
a tax in lieu of a generally imposed tax.
The second issue involves whether the League is a proper taxing authority,
and whether Harkonnen exhausted all effective and practical remedies by
petitioning the Holy Royal Court on the League’s tax.
First, the League is a sovereign entity with the authority to exact taxes
because governmental bodies within Arrakis, other countries, and the President of
the United States recognize it as a legitimate government. Importantly, Executive
Order 14012 compels executive agencies to recognize the League as a “sovereign
10
friend of the United States” and to establish trade relations with the League.
Therefore, the League is a proper taxing authority to which foreign tax credits
should be granted.
Finally, Harkonnen exhausted all effective and practical remedies when it
petitioned the Holy Royal Court for a resolution on its protest on the League’s tax.
Courts do not strictly construe an exhaustion of all effective and practical remedies.
The Holy Royal Court’s final decision on Harkonnen’s tax dispute with the League
terminated any further avenues of relief.
Therefore, this Court should reverse the holding of the Fourteenth Circuit.
11
ARGUMENT
In 1918, Congress, having realized the evil of double taxation, enacted
legislation to allow foreign tax credits for domestic companies operating abroad.
Revenue Act of 1918, ch. 18, 40 Stat. 1057; see also United States v. Goodyear Tire
& Rubber Co., 493 U.S. 132, 139 (1989); Am. Chicle Co. v. United States, 316 U.S.
450, 451 (1942). A secondary purpose was to stimulate foreign trade. Inland Steel
Co. v. United States, 677 F.2d 72, 80 (Ct. Cl. 1982). As such, Royal Harkonnen Oil
Company (“Harkonnen”) and other similarly situated companies have engaged in
foreign commerce within foreign countries. However, the Commissioner of the
Internal Revenue Service (the “Commissioner” or “IRS”) denied Harkonnen’s credit
for taxes paid to the Republic of Arrakis (“Arrakis”) and the Inter-Sietch Fremen
Independence League (the “League”), but notably granted a foreign tax credit for
taxes paid to the Sietch State.
The issues before this Court are (1) whether the RAFT, as designed,
sufficiently reaches the net gain of foreign entities operating machinery in its
territory,1 and (2) whether Harkonnen properly paid taxes to the League and
exhausted all effective and practical remedies when it sought a final resolution from
the highest court of Arrakis. This Court should find that the RAFT formula
necessarily reaches net income, and thus qualifies as a foreign tax credit under
either I.R.C §§ 901 or 903. Likewise, this Court should also hold that the League is
Other issues such as credit limitations, I.R.C. § 904 (2012), or specials rules concerning foreign oil
and gas income, § 907, will not be discussed because they are outside the scope of the issues on
appeal.
1
12
a proper taxing authority because Arrakis’ highest court and neighboring countries
have recognized the League’s legitimacy as a governmental body of Arrakis.
I.
The RAFT qualifies as a foreign tax credit under § 901 when it is formulated,
in substance, to be compulsory and its effect sufficiently reaches net gain.
While the tax structures between the Sietch State and Arrakis are identical,
but for the nominal difference in allowed deductions, the Commissioner remarkably
granted a foreign tax credit for the Sietch State taxes but denied those from
Arrakis, claiming that such taxes failed to sufficiently reach net income. The
Commissioner’s conflicting position failed to correctly apply the Regulations.
Therefore, this Court should hold that the RAFT reaches net gain and qualifies as a
valid foreign tax credit.
A.
The dual capacity taxpayer status is inapplicable where the RAFT is
generally imposed on all foreign entities regardless of the foreign
entities’ business operations in Arrakis.
In analyzing whether a tax qualifies as a foreign tax credit, the initial inquiry
is whether the taxpayer has a dual capacity status. In other words, did the
taxpayer receive a specific economic benefit for paying the tax? Dual capacity
taxpayer status does not apply because the RAFT is generally applied to all foreign
entities, regardless of the type of activities the foreign entity conducts in Arrakis.
The Regulations state that a foreign levy is not considered an income tax
when the “person subject to the levy receives . . . , directly or indirectly, a specific
economic benefit . . . from the foreign country in exchange for payment pursuant to
the levy.” Treas. Reg. § 1.901-2(a)(2)(i) (2013). A specific economic benefit is, inter
alia, a “right to use, acquire or extract resources . . . .” § 1.901-2(a)(2)(ii)(B).
13
However, if a levy applies to both dual capacity taxpayers and other taxpayers
equally, then such levy is not considered paid in exchange for a specific economic
benefit. § 1.901-2A(a)(1) (1983). Accordingly, the analysis of whether the RAFT is a
qualified foreign tax credit should proceed under § 1.901-2(a)(1).
Example 2 of § 1.901-2A(a)(2) precisely explains the inapplicability of dual
capacity taxpayer status to Harkonnen. Example 2 states that, in short, if country
X levies an income tax of 40% for all corporations doing business in country X, and
such corporations are allowed recovery of costs and expenses except for corporations
engaged in the exploitation of minerals, then the mineral corporations are dual
capacity taxpayers. § 1.901-2A(a)(2), Ex. 2; see also Appendix C. Example 2 further
elaborates that where the mineral corporations and all other corporations are
subject to the same income tax of 40% less applicable allowances and deductions,
then the mineral corporations are not dual capacity taxpayers. Id.
Here, Arrakis has imposed a general income tax on all of its citizens and
entities. Realizing that companies outside its borders were consuming the country’s
resources without bearing any tax liability, President Corrino enacted the RAFT.
As drafted, the RAFT “applied to all foreign entities that operate machinery on
sovereign territory of Arrakis.” R. at 5. Whether a corporation engages in oil
exploration or space exploration in Arrakis, all such companies are required to pay
a tax of 33% on its gross receipts less applicable deductions. The fact that the
RAFT is generally imposed exactly mirrors Example 2 of the Regulations.
14
Therefore, dual capacity taxpayer status analysis is inapplicable to foreign entities
such as Harkonnen.
B.
The Arrakis Constitution empowers the Arrakis Central Bank a
confiscatory withholding of all foreign entities’ gross receipts, and
deducting applicable taxes before returning the net gain to such
foreign entities.
The government of Arrakis operates under the authority of the Arrakis
Constitution. The Arrakis Constitution grants its president the power to enact one
new tax each year. Under such a structure, foreign entities are to turn over all
gross receipts to the Central Bank, which in turn deducts applicable taxes from
those gross receipts before disbursing the remainder back to the foreign entities.
Foreign entities may petition the Holy Royal Court on all matters regarding tax
disputes. The tax system of Arrakis, therefore, compels tax liability on foreign
entities such as Harkonnen.
A foreign income tax is qualified for credit if it is (1) a tax2 and (2)
predominantly characteristic of a tax in the U.S. sense.3 Treas. Reg. § 1.901-2(a)(1)
(2013). The Regulations define a tax as a “compulsory payment pursuant to the
authority of a foreign country.” Proctor & Gamble Co. v. United States, No. 1:08-cv00608, 2010 WL 2925099, at *5 (S.D. Ohio, July 6, 2010); see also § 1.901-2(a)(2).
Compulsory payments do not include penalties, fines, interest, custom duties, or
A fair reading of the record reveals that the Commissioner does not contend that the Arrakis tax
fails this element. For purposes of completeness, however, this Brief will discuss how this element is
satisfied and favors Harkonnen.
3 According to the record, the Commissioner contends, and the district court and Fourteenth Circuit
affirmed, that the RAFT failed to reach net income, which is the third element of the predominant
character test. R. at 16-17. This brief, however, will also discuss how the RAFT also satisfied the
realization and gross receipts elements of the test because it is not clear whether the Commissioner
contested those elements.
2
15
similar obligations. IBM v. United States, 38 Fed. Cl. 661, 668 (1997); see also §
1.901-2(a)(2). A payment is compulsory even when the taxpaying entity is taximmune but overruled by authority of the foreign government. See generally Riggs
Nat’l Corp. & Subsidiaries v. Comm’r, 163 F.3d 1363 (D.C. Cir. 1999) (holding that
Brazil’s tax was compulsory upon its own central bank when the bank assumed
responsibilities from third party borrowers); Amoco Corp. v. Comm’r, 138 F.3d 1139
(7th Cir. 1998) (holding that the Egyptian General Petroleum Corporation, an
entity of the Egyptian government, was liable for taxes). A tax is compulsory when
a nation exacts it by way of its sovereign powers. Phillips Petroleum Co. v. Comm’r,
104 T.C. 256, 295 (1995). Essentially, “[i]t is a required contribution to the
governmental revenue without [an] option to pay.” Id. (citing Cox v. Comm’r, 41
T.C. 161, 164 (1963)).
In Riggs, the Brazilian government-controlled Central Bank (“CB”) subsumed
the position of the country’s debtors that owed to foreign lenders. Riggs, 163 F.3d at
1365. The CB, by authority of the Brazilian Constitution, was a tax-immune entity
of Brazil. Id. at 1366. However, because of the way the Brazilian system was set
up, the “Minister of Finance—the highest ranking Brazilian authority on tax
matters—obliged them” to taxes, negating the CB’s tax immunity. Id. (“The ruling
concluded that the [CB]—notwithstanding its tax-immune status—was required
under Brazilian law to pay the tax obligation assumed from lenders . . . .”). The
taxpayer claimed that tax payments made on its behalf by the CB were compulsory,
and thus qualified it for foreign tax credits. Id. The circuit court agreed and relied
16
on the act-of-state doctrine to substantiate its holding. Id. at 1367. In short, the
act-of-state doctrine “directs United States courts to refrain from deciding a case
when the outcome turns upon the legality or illegality of official action by a foreign
sovereign performed within its own territory.” Id. (citing W.S. Kirkpatrick & Co. v.
Envtl. Tectonics Corp., 493 U.S. 400, 406 (1990)). Because the Minister of Finance’s
ruling was legally binding under Brazil’s laws, the tax was compulsory upon the CB
and not voluntary until otherwise challenged and invalidated. Riggs,163 F.3d at
1368.
Here, the taxes paid to Arrakis were compulsory. First, the Arrakis
Constitution allows the President of Arrakis to enact one new tax every year. The
President also has the power to enforce the laws of Arrakis. The Holy Royal Court,
which is the judicial branch of Arrakis, possesses exclusive jurisdiction over all tax
matters within Arrakis. Like Riggs, President Corrino, by way of the Arrakis
Constitution, is the highest ranking authority allowed to enact taxes, and his
passage of the RAFT mandates that all foreign citizens and entities operating
within Arrakis submit tax payments accordingly. This enactment was an “official
action by a foreign sovereign performed within its own territory.” Riggs, 163 F.3d
at 1367. The only other body with authority over tax matters is the Holy Royal
Court, which did not issue any decisions contrary to President Corrino’s enactment.
Moreover, the RAFT compelled all foreign citizens and entities that were
profiting within its borders to submit all gross receipts to the Central Bank where
the Central Bank withheld applicable taxes. Under this system, Harkonnen had no
17
option but to submit to the RAFT as a compulsory tax. Thus, the RAFT is a
compulsory tax exacted by the sovereign powers of Arrakis.
C.
Under the Regulations, the RAFT satisfies all three parts of the
predominant character test.
In addition to proving that the RAFT is a tax, Harkonnen must also satisfy
the three-part test of the Regulations known as the “predominant character” test.
Treas. Reg. § 1.901-2(a)(1)(ii) (2013). “The predominant character of a foreign tax is
that of an income tax in the U.S. sense if . . . the foreign tax is likely to reach net
gain in the normal circumstances in which it applies.” Entergy Corp. & Affiliated
Subsidiaries v. Comm’r, 683 F.3d 233, 234 (5th Cir. 2012); see also § 1.901-2(a)(3)(i).
When analyzing a foreign levy, courts should look to the substance of the tax and
not strictly construe it according to form. PPL Corp. v. Comm’r, 133 S. Ct. 1897,
1899-900 (2013) (holding that when analyzing the predominant character test,
courts should use the “commonsense approach that considers the substantive effect
of the tax”); Entergy Corp., 683 F.3d at 236 (“The label and form of [a] foreign tax is
not determinative.”) (citing Inland Steel, 677 F.2d at 80)). “[T]he black-letter
principle [is] that tax law deals in economic realities, not legal abstractions.” PPL
Corp., 133 S. Ct. at 1905; see also Biddle v. Comm’r, 302 U.S. 573, 579 (1938). Net
gain is determined by (1) a realization event, (2) gross receipts, and (3) net income.
§ 1.901-2(b)(1).
18
1.
The RAFT is designed to impose tax liability upon or subsequent
to the realization of gross receipts.
“A foreign tax satisfies the realization requirement if, judged on the basis of
its predominant character, it is imposed upon or subsequent to the occurrence of
events that would result in the realization of income.” Treas. Reg. § 1.9012(b)(2)(i)(A)-(C) (2013). Under U.S. laws, realization occurs when there is an
exchange of property for value. See Treas. Reg. § 1.1001-1(a) (2007) (“[T]he gain or
loss realized from the conversion of property into cash, or from the exchange of
property for other property differing materially either in kind or in extent, is
treated as income or as loss sustained.”); Bittker & Lokken, Federal Taxation of
Income, Estates & Gifts ¶ 72.4.3 (2011) (a realization event generally occurs “when
property is sold or exchange”); Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 430-31
(1955). The realization of gain does not have to be cash from a sale of an asset but
can “occur as a result of exchange of property, payment of the taxpayer’s
indebtedness, relief from a liability, or other profit realized from the completion of a
transaction.” Helvering v. Bruun, 309 U.S. 461, 469 (1940). Additionally, the
discovery of something of value from, for example, a treasure trove satisfies the
realization event. See Cesarini v. United States, 428 F.2d 812, 813 (6th Cir. 1970).
Under the Regulations, a foreign levy satisfies the realization requirement
when it is imposed prior to,4 upon, or subsequent to the realization event. § 1.9012(b)(2)(i)(A)-(C). In other words, realization occurs when a taxpayer sells oil in the
The “prior to” provision is known as the “prerealization event,” which is inapplicable to the present
case because the RAFT does not tax income before a foreign entity realizes income. Therefore, this
provision will not be discussed.
4
19
market and obtains cash in return. Consider, for example, that a foreign levy
imposed taxes on the gross receipts of oil production for companies engaged in such
activities. Under these circumstances, the tax would be considered a tax imposed
“upon or subsequent to” a realization event of gross receipts. That is, the company
has realized gains or losses at the point of exchange.
Here, the Arrakis tax was based on gross receipts. The gross receipts
occurred only when Harkonnen produced and sold its barrels of oil. At the moment
Harkonnen produced its barrels of oil, it has obtained potential value. Once that
potential value is exchanged for actual monetary value, realization is satisfied. As
such, Harkonnen incurred tax liability when it exchanged its barrels of oil on the
market. The RAFT was designed precisely to impose tax liability at that point of
exchange. Thus, the RAFT was imposed “upon or subsequent to” a realization
event, and satisfies this requirement.
2.
The RAFT bases liability upon a foreign entity’s gross receipts.
To satisfy the gross receipts requirement, a foreign levy must be based on
either (1) gross receipts, or (2) gross receipts computed under a method that is likely
to produce an amount that is not greater than fair market value. Treas. Reg. §
1.901-2(b)(3)(i) (2013). The RAFT calculates tax liability as: gross receipts less
applicable deductions multiplied by the tax percentage (T = (GR – D) x 0.33).
Because the RAFT was based strictly on gross receipts, it has satisfied this
requirement.
20
3.
President Corrino’s Proclamation 102 allows all foreign entities
to recover a significant portion of costs and expenses.
While Arrakis initially founded its tax structure upon religious tenets,
President Corrino enacted and revised the RAFT to comport with international
standards. President Corrino issued Proclamation 102 to allow for the recovery of
costs and expenses. Without Proclamation 102, the RAFT would surely fail to meet
the requirements of net income for foreign tax credit purposes. However, where a
foreign levy allows some measurable recovery of costs and expenses, it would satisfy
the net income requirement and qualify as a foreign tax credit.
“A foreign tax satisfies the net income requirement if, judged on the basis of
its predominant character, the base of the tax is computed by reducing gross
receipts . . . to permit” either recovery of significant costs and expenses or “recovery
of such significant costs and expenses computed under a method that is likely to
produce an amount that approximates, or is greater than, recovery of such
significant costs and expenses.” Treas. Reg. § 1.901-2(b)(4)(i)(A)-(B) (2013); see also
Exxon Corp. v. Comm’r, 113 T.C. 338, 351-52 (1999). A foreign levy is creditable if
it is substantially equivalent to income taxes in the U.S. sense. See Comm’r v. Am.
Metal Co., 221 F.2d 134, 136 (2d Cir. 1955). Foreign levies are income taxes when it
is “designed to effectively reach some net gain or profit.” Bank of Am. Nat’l Trust &
Savs. Ass’n v. United States, 459 F.2d 513, 517-19 (Ct. Cl. 1972). When
determining the method by which income taxes are computed, a foreign method
need not strictly conform to the U.S. method. See Santa Eulalia Mining Co. v.
Comm’r, 2 T.C. 241, 245 (1943). The analysis of non-recoverable costs and expenses
21
can turn to either an aggregate or a return-by-return consideration. See Texasgulf,
Inc. & Subsidiaries v. Comm’r, 172 F.3d 209, 215 (2d Cir. 1999).
In Texasgulf, the taxpayer corporation undertook mining operations in
Canada. Id. at 210-11. Canada had imposed a tax called the Ontario Mining Tax
(“Ontario Tax”), which applied to mining operations in various provinces of Canada.
Id. at 211-12. A company subject to the Ontario Tax became liable for taxes when
its production exceeded an allowable statutory amount. Id. at 211. The Ontario
Tax further allowed certain recovery of costs and expenses, known as processing
allowances. Id. at 212. For ten of the thirteen years, Texasgulf was subject to the
Ontario Tax because its allowances exceeded its non-recoverable expenses. Id. at
213. The IRS disqualified claims for foreign tax credits for those three years
because, it argued, the Ontario Tax failed to sufficiently reach net gain for those
three years. Id. at 210. The Second Circuit rejected that argument and held that
the Ontario Tax did sufficiently reach net gain. Id. at 217. In reaching its decision,
the Second Circuit analyzed the language of the Regulations. Specifically, the court
looked at the words “effectively compensate” and “approximates, or is greater than”
to conclude that even though non-recoverable expenses did exceed allowances at
times, overall, the allowances sufficiently compensated for expenses as required by
the Regulations. Id. at 215-16.
Similarly, Exxon involved a United Kingdom Petroleum Revenue Tax
(“Petroleum Tax”) imposed upon oil companies engaged in oil exploration,
production, refining, and sale. Exxon Corp., 113 T.C. at 338. Under the Petroleum
22
Tax, interest income was nondeductible, but allowances for uplift could exceed the
nondeductible interest. Id. at 347. In the aggregate, the uplift allowances totaled
$12.4B pounds as opposed to the nondeductible interest expenses of $8.6B pounds.
Id. at 347-48. According to the court’s appendix, the nondeductible interest expense
exceeded the uplift allowances in years 1977 and 1979. Id. at 361.
The tax court ruled that the Petroleum Tax satisfied the net income
requirement because the uplift allowances, in the aggregate, “significantly
exceeded” the disallowed interest expenses. Id. at 357. The court further claimed
that even if a company-by-company analysis were to be used, Exxon would still
satisfy the net income requirement because the company was one out of five that
paid approximately 75% of the total Petroleum Tax. Id. at 359.
Under the present facts, the RAFT satisfied the net income requirement
because Proclamation 102 allowed all foreign companies to take deductions from
their gross receipts. While the empirical numbers are limited in the record, it could
be presumed that the allowed deductions effectively and approximately
compensated for costs and expenses incurred by Harkonnen. Assume, for example,
the two sets of hypotheticals below. The first set juxtaposes an instance where the
RAFT allowed for 100% of deductions compared to a 95% limitation:
23
Gross receipts
Costs & Expenses
Tax =
The RAFT at 100% Allowable Deductions
$50M
$10M
($50M-$10M)*(0.33)
$13.2M
Gross receipts
Costs & Expenses
Tax =
The RAFT at 95% Allowable Deductions
$50M
$10M-$0.50M = $9.5M
($50M-$9.5M)*(0.33)
$13.365M
The practical effect of the 95% limitation is a difference of approximately
$165k ($13.365M - $13.2M), which when compared to the gross receipts, is nominal.
However, in the case where Harkonnen does not incur $10M of costs and expenses
but instead has $1M of costs and expenses, then the difference becomes
inconsequential when compared to the company’s gross receipts:
Gross receipts
Costs & Expenses
Tax =
Gross receipts
Costs & Expenses
Tax =
The RAFT at 100% Allowable Deductions
$50M
$1M
($50M-$1M)*(0.33)
$16.17M
The RAFT at 95% Allowable Deductions
$50M
$1M-$0.05M = $0.95M
($50M-$0.95M)*(0.33)
$16.18M
The effect of the 95% limitation in the second set is approximately $10k
($16.18M - $16.17M), an amount so insignificant that it has no real impact on the
calculation of net income. Cf. Texasgulf, 172 F.3d at 214 (finding that nonrecoverable expenses were at least 1% compared to gross receipts but satisfied the
net income requirement nonetheless). Under the first set of the hypotheticals
24
where Harkonnen incurred $10M of costs and expenses, the non-recoverable
expenses difference was less than 0.33%. The second set of hypotheticals where
Harkonnen incurred $1M of costs and expenses, the non-recoverable expenses
difference was 0.02%.5 Having assumed these figures, the RAFT is designed in such
a way that the 95% limitation on allowable deductions has no real impact on
calculating net income. The operative words in the Regulations include
“approximates, or is greater than.” § 1.901-2(b)(4)(i)(B) (emphasis added). For the
95% limitation on deductions to have an effect on net income, Harkonnen’s costs
and expenses would have to be so astronomically high that no real company could
continue to operate from year to year.
Moreover, the Regulations demand a recovery of “significant” costs and
expenses. § 1.901-2(b)(4)(i)(A)-(B). The 95% limitation on deductions realistically
reduces costs and expenses to the point of being so “insignificant” that when
compared to the amount of gross receipts, net income is almost always reached.
Accordingly, the deduction approximately allows for the recovery of costs and
expenses that, when computed, the limitation has no measurable impact on the
determination of net income. Therefore, this Court should find that the RAFT
satisfies all three parts of the predominant character test and qualifies as a foreign
tax credit.
The figures were presented to illustrate the fact that net income is almost always reached under
the Arrakis tax structure. In reality, companies like Harkonnen produce gross receipts well above
the hypothetical numbers so as to make the disparity between gross receipts and costs and expenses
greater than those in the hypotheticals.
5
25
D.
Alternatively, the RAFT’s structure qualifies as a tax in lieu of a
generally imposed domestic tax.
A foreign levy that fails to qualify as a foreign tax credit under I.R.C. § 901
(2012) can qualify as a foreign tax credit under § 903 if it is (1) a tax6 (2) paid in lieu
of a generally imposed tax. § 903. To satisfy this section, the Regulations instruct
that the tax is a tax within the meaning of Treasury Regulations § 1.901-2(a)(2)
(2013), and that it meets the substitution requirement. § 1.903-1(a) (1983).
Moreover, a foreign levy would fail this section if it was dependent upon the
availability of a tax credit against the income tax liability of another country—
“soak-up taxes.” § 1.903-1(b)(2).
An example where a foreign levy satisfies the substitution requirement is as
follows:
Country X has a tax on realized net income that is generally imposed
except that nonresidents are not subject to that tax. Nonresidents are
subject to a gross income tax on income from country X that is not
attributable to a trade or business carried on in country X. The gross
income tax imposed on nonresidents satisfies the substitution
requirement set forth in this paragraph (b).
§ 1.903-1(b)(3), Ex. 1. This example nearly mirrors the present case. Arrakis has
two types of levies. The first Arrakis tax is generally imposes a tax upon its
citizens. R. at 4. It was not until 2008 that President Corrino enacted a second tax:
the RAFT. The RAFT applied only to foreign entities operating machinery within
Arrakis’ borders—a class entirely separate from Arrakis citizens. Moreover, foreign
The analysis of whether the RAFT is a tax under § 903 is identical to the analysis under § 901.
Please refer to section I.B of the brief for an analysis of whether the RAFT is a valid tax.
6
26
entities are not subject to the generally imposed Arrakis tax. As such, the RAFT
qualifies as a foreign tax credit under both §§ 901 and 903.
II.
The laws of Arrakis recognize the sovereignty of the League, which in turn
may exact taxes upon citizens and entities within its territory.
The validity of a foreign tax credit requires that the foreign entity to which
taxes are paid possesses the proper authority to impose taxes in the first place.
While certain provisions of the foreign tax credit continue to change, one provision
has remained consistent since 1932: foreign countries or their political subdivisions
may exact taxes that are creditable when done so in accordance with their sovereign
powers.
The governmental structure of Arrakis is as follows: the country of Arrakis is
the overall governing body; the Sietch State is a political subdivision that gained its
independence in 2010; the League is a second political subdivision that gained its
independence in 2011. As a result, each individual body possesses sovereign
powers—including taxing powers—to govern individuals within its borders.
The issues here are whether the League’s imposition of a 2% tax was
creditable when executed pursuant to its sovereign authority, and whether
Harkonnen exhausted all effective and practical remedies when it sought a final
resolution from the Holy Royal Court. Because the League obtained independence,
which the Holy Royal Court affirmed, and was legitimately recognized by various
countries, this Court should hold that the League is a proper taxing authority.
Likewise, this Court should also hold that Harkonnen exhausted all effective and
practical remedies when it sought a tax decision from the Holy Royal Court.
27
A.
The Holy Royal Court, neighboring countries, and the United States
per Executive Order 14012 have recognized the League as a sovereign
entity capable of levying taxes.
The issue here is whether the League’s tax failed as a compulsory tax because
it was not imposed pursuant to the authority of a legitimate foreign country.7 The
League is an independent political subdivision within Arrakis, and thus, is a proper
taxing authority.
A tax is compulsory if levied pursuant to a foreign country’s proper taxing
authority. Treas. Reg. § 1.901-2(a)(2)(i) (2013). “Foreign country” is defined as “any
foreign state, . . . and any political subdivision of any foreign state . . . .” § 1.9012(g)(2); see also Procter & Gamble Co., 2010 WL 2925099, at *9 (holding that the
municipality of South Korea was a political subdivision). Foreign country, state, or
political subdivision is “used in the sense of government.” Burnet v. Chi. Portrait
Co., 285 U.S. 1, 7 (1932) (“The word ‘country’ is manifestly used in the sense of
government.”). A foreign government may be viewed on the larger scale—an
“international person with the rights and responsibilities under international law of
a member of the family of nations”—or a smaller scale—“authority over a particular
area or subject-matter.” Id. at 5; see also Internal Rev. Serv., Publication 514,
Foreign Tax Credit for Individuals 6 (Jan. 14, 2014), available at
http://www.irs.gov/pub/irs-pdf/p514.pdf (“A foreign country includes . . . a foreign
A foreign tax credit is satisfied if it is (1) a tax and (2) predominantly characteristic of a tax in the
U.S. sense. The issues of whether a foreign country is a valid taxing authority and whether the
taxpayer exhausted all practical remedies are all contained under the first part of the foreign tax
credit analysis. The IRS and lower courts only focused on the first part of the foreign tax credit
analysis. Therefore, the predominant character analysis will not be discussed.
7
28
city or province.”). A foreign country’s authority to exact a levy turns on whether
that government is competent to lay a tax. Chi. Portrait Co.. 285 U.S. at 10.
However, even if a government falls within the definition of “foreign country,”
it can still be disqualified as a foreign tax credit due to a non-recognition of or
severed relations with the United States. I.R.C. § 901(j)(2) (2012). Taxpayers
operating in “blacklisted” countries may nonetheless obtain a foreign tax credit if
that foreign country has received a United States Presidential waiver in accordance
with § 901(j)(5). The President, prior to issuing such a waiver, must report to
Congress. § 901(j)(5)(B). The President of the United States grants such waivers
when he or she determines that it is in the “national interest of the United States
and will expand trade and investment opportunities for U.S. companies in such
country.” Rev. Rul. 2005-3, 2005-1 C.B. 334. In contrast, the President may issue
executive orders, directing agencies of the executive branch to perform certain
actions. See United States v. Borja, 191 F. Supp. 563, 566-67 (D. Guam. 1961).
Executive orders have the force and effect of law. See Harris v. United States, 19
F.3d 1090, 1093 (5th Cir. 1994). Additionally, the Commissioner is an arm of the
executive branch, and must comply with executive orders issued by the President.
See I.R.C. § 7803(a)(1)(D) (2012) (“The Commissioner may be removed at the will of
the President.”).
In Chicago Portrait, the issue revolved around whether, for purposes of a
foreign tax credit, the term “foreign country” was strictly construed to include only
the larger political body of government. Chi. Portrait Co., 285 U.S. at 4. The
29
Chicago Portrait Company (“CPC”) owned a majority of stock in a foreign
corporation. Id. As a result of its stock ownership, the CPC received dividends from
the foreign corporation. Id. The foreign corporation paid taxes on the dividends
and the CPC sought credit on those taxes. Id. The Commissioner allowed tax
credits for the Commonwealth of Australia and the Dominion of New Zealand
(countries in the continent), but denied credits for the State of New South Wales (a
state of the Commonwealth of Australia). Id.
In determining whether New South Wales was a “foreign country” for
purposes of a foreign tax credit, the Court analyzed the purpose of the foreign tax
credit legislation. Id. at 7. The Court found that the legislative purpose was to
“give greater not less relief.” Id. at 15. It reasoned that a “foreign country” was an
expansive term and included smaller units of a centralized government. See id. at
9-10. The Court stated that the “controlling consideration” was the competency of
the government to lay taxes, irrespective of its international standing. Id. at 10-11,
17 (stating that “it was enough that [New South Wales] had authority to require
payment as a condition to carrying on business”) (internal quotations omitted).
Because New South Wales was a political subdivision of the Commonwealth of
Australia, and the levy imposed was within its authority, the Court concluded that
New South Wales fell within the definition of “foreign country.” Id. at 21.
In the present case, the League is a political subdivision of Arrakis. First,
the League has been functioning as an independent political regime since 2008.
The League’s political structure involves an annual vote for a Leader Elect. There
30
are seven electoral votes cast by three parties: the Al Dhanab family, the Anbus
family, and individuals pledging membership to the League. Subsequent to the
Sietch State’s independence, the League launched its own independence campaign
within Arrakis. In 2011, the League obtained control of an area within the Sietch
Dunes known as the Badlands—setting it apart from the Sietch State. Second, Al
Dhanab, Anbus, France, and Russia all recognized the legitimacy of the League’s
independence. Third, when Harkonnen petitioned the Holy Royal Court for a
determination of the League’s legitimacy and authority to tax, the Holy Royal Court
held that “Arrakis recognizes [the League] as a part of Sietch.” R. at 14. Fourth,
both Arrakis and the Sietch State implicitly recognized the League’s independence
by agreeing to establish a permanent location for the League’s headquarters. Lastly
and most importantly, the President of the United States issued Executive Order
14012, directing that the League is a friend of the United States and that the
United States would like to establish trade relations with the League.
It is important to consider Executive Order 14012. Pursuant to the powers
vested in the President of the United States, he issued the Order to recognize the
sovereignty of the League. The Commissioner cannot reject Executive Order 14012
as it is issued with the force of law, and because the Commissioner is an agency of
the executive branch, the Commissioner must comply with the Order. This Order is
permissible as opposed to a Presidential waiver because the League was never
blacklisted. The President’s Order carries more weight than those made by the U.S.
State Department, which is a subordinate agency to the President. On June 2010,
31
the State Department established trade relations with the Sietch State, declaring it
“A Quasi-Autonomous Region.” R. at 10. As a result, the Sietch State’s taxes
qualified as a foreign tax credit. The President’s Order is synonymous with the
State Department’s actions, and accords the League the same treatment as the
Sietch State. Therefore, the Commissioner is bound by Executive Order 14012,
which qualifies the League’s taxes as valid foreign tax credits.
Arguably, the Commissioner could contend that regardless of whether other
countries recognize the League, Arrakis and the Sietch State have explicitly denied
the League’s legitimacy. If the League is recognized as a political subdivision of the
Sietch State, the Commissioner may also contend that the League’s tax is in
violation of the Peace Treaty because it allows only one tax within the Sietch State.
In addition, the Commissioner may argue that § 901(j)(2)(A)(iv) rejects any foreign
tax credits from countries with ties to terrorist organizations.
While the Commissioner’s first point may carry some merit, the Holy Royal
Court’s decision regarding the League’s legitimacy supersedes Arrakis’ and the
Sietch State’s rejection. Subsequently, both Arrakis and the Sietch State took
measures to establish a permanent location for the League. The Commissioner’s
second point also fails because the League is not a subdivision of the Sietch State.
Rather, the League is a political subdivision of Arrakis, making it a second state of
Arrakis. Therefore, the League’s tax does not violate the Peace Treaty, which
applied only to the Sietch State.
32
Lastly, any contention that the League is connected to the Bene Gesserit
terrorist organization is misplaced because “fear is the mind killer.” See Frank
Herbert, Dune 19 (1965). Section 901(j)(2)(A)(iv) requires that a country
“repeatedly” harbors international terrorism. The facts are clear that the League’s
only relation to the Bene Gesserit is through Mohiam’s mother, of whom Mohiam
has rejected since she turned eighteen. For the Commissioner to fear the League’s
association with terrorism through the right of birth is unwarranted.
The League’s circumstances, under the Chicago Portrait analysis, is a
textbook example of satisfying both competent powers to tax, as well as an
international recognition to tax. Thus, this Court should hold that the League is a
valid “foreign country” or political subdivision of Arrakis, that has the authority to
impose taxes, because the League is recognized by its country’s laws as a legitimate
entity and is supported as a sovereign entity on an international level.
B.
Harkonnen exhausted all effective and practical remedies by
petitioning the Holy Royal Court for a resolution on its taxes to the
League.
The issue here is whether Harkonnen exhausted all effective and practical
remedies prior to paying taxes to the League. The Council is a judicial body of the
Sietch State with the powers to only decide matters for the Sietch State. The Holy
Royal Court, like the Supreme Court of the United States, is the highest court of
Arrakis, and it has exclusive jurisdiction on “all legal tax disputes.” R. at 14.
Therefore, the Holy Royal Court’s decision on Harkonnen’s tax matter was the
exhaustion of all effective and practical remedies.
33
The exhaustion of all effective and practical remedies element falls under the
definition of non-compulsory payments, which states: (1) taxpayer’s determination
of tax liability must be based on the interpretation of the foreign law, (2)
interpretation must be reasonable, and (3) the taxpayer exhausted all effective and
practical remedies. IBM Corp., 38 Fed. Cl. at 668 (emphasis added) (deducing the
three elements from the Regulations); Treas. Reg. § 1.901-2(e)(5)(i) (2013).
Interpretation of a foreign levy is satisfied where the taxpayer has taken steps to
determine whether there is tax liability. IBM Corp., 38 Fed. Cl. at 669-72.
Reasonableness is established upon a “good faith” reliance from a “competent
foreign tax advisor[ ].” § 1.901-2(e)(5)(i). Finally, an exhaustion of all effective and
practical remedies includes the “invocation of competent authority procedures
available under applicable tax treaties.” Id.
In IBM, the plaintiff was the parent corporation of a group of corporations
operating in Italy. IBM, 38 Fed. Cl. at 662. The plaintiff paid the revised Italian
tax and filed for a credit with the Commissioner. Id. at 663-64. The Italian tax,
prior to its revision, did not apply to the plaintiff. See id. at 663. The
Commissioner disallowed the credit, claiming, inter alia, that the Italian tax was
not a tax. See id. at 667-69. The Federal Claims court analyzed all three elements
of the non-compulsory payment test. See id. at 670-675. First, the court found that
the plaintiff had interpreted the revised Italian tax by obtaining advice from an
Italian tax expert, who in turn, obtained his knowledge from an interpretation set
out by the taxing authority of Italy. Id. at 669, 671. Next, the court found that the
34
interpretation was reasonable because the plaintiff relied on a tax expert. Id. at
673. Moreover, the plaintiff relied in good faith on the interpretation from the tax
expert. Id. Lastly, the plaintiff exhausted all effective and practical remedies
because there was no competent authority that governed its issue—the court
dismissed the Commissioner’s contention that the plaintiff’s Italian litigation has
not concluded, and thus was not an exhaustion of remedies. Id. at 673-75 (stating
that “the final regulations could have specified that exhaustion of ‘all practical and
effective litigation’ meant exhaustion of all litigation, including the appellate
process”). The court found that the Commissioner supported the position that
taxpayers engaged in tax liability litigation in foreign jurisdictions could claim a
credit but must later report to the Secretary of Treasury if a refund occurs. § 901(c);
Rev. Rul. 70-290, 1970-1 C.B. 160 (“A corporation is not deprived of the right to
obtain credit for foreign taxes because it contests the validity of the statutes under
which the taxes were paid or protests the assessment and has made application for
a refund.”).
Here, the Commissioner contends that Harkonnen failed to exhaust all
effective and practical remedies because it failed to raise a claim with the Council.
The Commissioner’s argument is misplaced for two reasons. First, the Council is a
judicial body established to handle judicial affairs for the Sietch State. The League,
however, is a separate entity and not bound to the Sietch State’s jurisdiction.
Second, even if Harkonnen had to go before the Council first, the Council’s decision
is not final because it is a lower judicial body. The Holy Royal Court handles all tax
35
matters and is the highest court of the land. Thus, requiring Harkonnen to bounce
between courts is both ineffective and impractical. Because the Holy Royal Court
has made a determination on the League’s status, its decision, as an act-of-state,
cannot be questioned. See Riggs Nat’l Corp. & Subsidiaries, 163 F.3d at 1363.
Harkonnen also satisfied the remaining two elements. Harkonnen
interpreted the liability of the League’s tax by petitioning an answer from the Holy
Royal Court. Since the Holy Royal Court decided all matters pertaining to taxes, it
is a competent authority to interpret the issue. Harkonnen also relied in good faith
on the court’s interpretation of the League’s imposed tax. Following the court’s
decision, Harkonnen relied on the court’s decision and paid the League the
mandated tax. Harkonnen has satisfied the three elements of the test, particularly
the exhaustion issue. Therefore, this Court should hold that Harkonnen exhausted
all effective and practical remedies.
CONCLUSION
For the foregoing reasons, this Court should reverse the Fourteenth Circuit.
Respectfully Submitted,
/s/ Counsel for Petitioner
Counsel for Petitioner
36
APPENDIX A
I.R.C. § 901 (2012)
§ 901. Taxes of Foreign Countries and of Possessions of United States
(a) Allowance of credit.—If the taxpayer chooses to have the benefits of this subpart,
the tax imposed by this chapter shall, subject to the limitation of section 904, be
credited with the amounts provided in the applicable paragraph of subsection (b)
plus, in the case of a corporation, the taxes deemed to have been paid under sections
902 and 960. Such choice for any taxable year may be made or changed at any time
before the expiration of the period prescribed for making a claim for credit or refund
of the tax imposed by this chapter for such taxable year. The credit shall not be
allowed against any tax treated as a tax not imposed by this chapter under section
26(b).
(b) Amount allowed.—Subject to the limitation of section 904, the following amounts
shall be allowed as the credit under subsection (a):
(1) Citizens and domestic corporations.—In the case of a citizen of the United
States and of a domestic corporation, the amount of any income, war profits,
and excess profits taxes paid or accrued during the taxable year to any
foreign country or to any possession of the United States; and
***
(j) Denial of foreign tax credit, etc., with respect to certain foreign countries.—
(1) In general.—Notwithstanding any other provision of this part—
(A) no credit shall be allowed under subsection (a) for any income, war
profits, or excess profits taxes paid or accrued (or deemed paid under
section 902 or 960) to any country if such taxes are with respect to
income attributable to a period during which this subsection applies to
such country, and
(B) subsections (a), (b), and (c) of section 904 and sections 902 and 960
shall be applied separately with respect to income attributable to such
a period from sources within such country.
A-1
(2) Countries to which subsection applies.—
(A) In general.—This subsection shall apply to any foreign country—
(i) the government of which the United States does not
recognize, unless such government is otherwise eligible to
purchase defense articles or services under the Arms Export
Control Act,
(ii) with respect to which the United States has severed
diplomatic relations,
(iii) with respect to which the United States has not severed
diplomatic relations but does not conduct such relations, or
(iv) which the Secretary of State has, pursuant to section 6(j) of
the Export Administration Act of 1979, as amended, designated
as a foreign country which repeatedly provides support for acts
of international terrorisms.
(5) Waiver of denial.—
(A) In general.—Paragraph (1) shall not apply with respect to taxes
paid or accrued to a country if the President—
(i) determines that a waiver of the application of such paragraph
is in the national interest of the United States and will expand
trade and investment opportunities for United States companies
in such country; and
(ii) reports such waiver under subparagraph (B).
(B) Report. —Not less than 30 days before the date on which a waiver
is granted under this paragraph, the President shall report to
Congress—
(i) the intention to grant such waiver; and
(ii) the reason for the determination under subparagraph (A)(i).
A-2
APPENDIX B
Treas. Reg. § 1.901-2 (2013). Income, War Profits, or Excess Profits Tax Paid or
Accrued
(a) Definition of income, war profits, or excess profits tax
(1) In general. Section 901 allows a credit for the amount of income, war profits or
excess profits tax (referred to as “income tax” for purposes of this section and §§
1.901–2A and 1.903–1) paid to any foreign country. Whether a foreign levy is an
income tax is determined independently for each separate foreign levy. A foreign
levy is an income tax if and only if—
(i) It is a tax; and
(ii) The predominant character of that tax is that of an income tax in the U.S.
sense.
Except to the extent otherwise provided in paragraphs (a)(3)(ii) and (c) of this
section, a tax either is or is not an income tax, in its entirety, for all persons
subject to the tax. Paragraphs (a), (b) and (c) of this section define an income
tax for purposes of section 901. Paragraph (d) of this section contains rules
describing what constitutes a separate foreign levy. Paragraph (e) of this
section contains rules for determining the amount of tax paid by a person.
Paragraph (f) of this section contains rules for determining by whom foreign
tax is paid. Paragraph (g) of this section contains definitions of the terms
“paid by,” “foreign country,” and “foreign levy.” Paragraph (h) of this section
states the effective date of this section.
***
(2) Tax--(i) In general. A foreign levy is a tax if it requires a compulsory payment
pursuant to the authority of a foreign country to levy taxes. A penalty, fine, interest,
or similar obligation is not a tax, nor is a customs duty a tax. Whether a foreign levy
requires a compulsory payment pursuant to a foreign country's authority to levy
taxes is determined by principles of U.S. law and not by principles of law of the
foreign country. Therefore, the assertion by a foreign country that a levy is
pursuant to the foreign country's authority to levy taxes is not determinative that,
under U.S. principles, it is pursuant thereto. Notwithstanding any assertion of a
foreign country to the contrary, a foreign levy is not pursuant to a foreign country's
authority to levy taxes, and thus is not a tax, to the extent a person subject to the
levy receives (or will receive), directly or indirectly, a specific economic benefit (as
defined in paragraph (a)(2)(ii)(B) of this section) from the foreign country in
exchange for payment pursuant to the levy. Rather, to that extent, such levy
requires a compulsory payment in exchange for such specific economic benefit. If,
B-1
applying U.S. principles, a foreign levy requires a compulsory payment pursuant to
the authority of a foreign country to levy taxes and also requires a compulsory
payment in exchange for a specific economic benefit, the levy is considered to have
two distinct elements: A tax and a requirement of compulsory payment in exchange
for such specific economic benefit. In such a situation, these two distinct elements of
the foreign levy (and the amount paid pursuant to each such element) must be
separated. No credit is allowable for a payment pursuant to a foreign levy by a dual
capacity taxpayer (as defined in paragraph (a)(2)(ii)(A) of this section) unless the
person claiming such credit establishes the amount that is paid pursuant to the
distinct element of the foreign levy that is a tax. See paragraph (a)(2)(ii) of this
section and § 1.901–2A.
(ii) Dual capacity taxpayers
(A) In general. For purposes of this section and §§ 1.901–2A and 1.903–1, a
person who is subject to a levy of a foreign state or of a possession of the
United States or of a political subdivision of such a state or possession and
who also, directly or indirectly (within the meaning of paragraph
(a)(2)(ii)(E) of this section) receives (or will receive) a specific economic
benefit from the state or possession or from a political subdivision of such
state or possession or from an agency or instrumentality of any of the
foregoing is referred to as a “dual capacity taxpayer.” Dual capacity
taxpayers are subject to the special rules of § 1.901–2A.
(B) Specific economic benefit. For purposes of this section and §§ 1.901–2A
and 1.903–1, the term “specific economic benefit” means an economic
benefit that is not made available on substantially the same terms to
substantially all persons who are subject to the income tax that is
generally imposed by the foreign country, or, if there is no such generally
imposed income tax, an economic benefit that is not made available on
substantially the same terms to the population of the country in general.
Thus, a concession to extract government-owned petroleum is a specific
economic benefit, but the right to travel or to ship freight on a
government-owned airline is not, because the latter, but not the former, is
made generally available on substantially the same terms. An economic
benefit includes property; a service; a fee or other payment; a right to use,
acquire or extract resources, patents or other property that a foreign
country owns or controls (within the meaning of paragraph (a)(2)(ii)(D) of
this section); or a reduction or discharge of a contractual obligation. It
does not include the right or privilege merely to engage in business
generally or to engage in business in a particular form.
***
B-2
(3) Predominant character. The predominant character of a foreign tax is that of an
income tax in the U.S. sense—
(i) If, within the meaning of paragraph (b)(1) of this section, the foreign tax is
likely to reach net gain in the normal circumstances in which it applies,
(ii) But only to the extent that liability for the tax is not dependent, within
the meaning of paragraph (c) of this section, by its terms or otherwise, on the
availability of a credit for the tax against income tax liability to another
country.
(b) Net gain
(1) In general. A foreign tax is likely to reach net gain in the normal
circumstances in which it applies if and only if the tax, judged on the basis of
its predominant character, satisfies each of the realization, gross receipts,
and net income requirements set forth in paragraphs (b)(2), (b)(3) and (b)(4),
respectively, of this section.
(2) Realization
(i) In general. A foreign tax satisfies the realization requirement if,
judged on the basis of its predominant character, it is imposed—
(A) Upon or subsequent to the occurrence of events (“realization
events”) that would result in the realization of income under the
income tax provisions of the Internal Revenue Code;
***
(3) Gross receipts
(i) In general. A foreign tax satisfies the gross receipts requirement if,
judged on the basis of its predominant character, it is imposed on the
basis of—
(A) Gross receipts; or
(B) Gross receipts computed under a method that is likely to
produce an amount that is not greater than fair market value.
A foreign tax that, judged on the basis of its predominant character, is imposed on
the basis of amounts described in this paragraph (b)(3)(i) satisfies the gross receipts
requirement even if it is also imposed on the basis of some amounts not described in
this paragraph (b)(3)(i).
B-3
***
(4) Net income
(i) In general. A foreign tax satisfies the net income requirement if,
judged on the basis of its predominant character, the base of the tax is
computed by reducing gross receipts (including gross receipts as
computed under paragraph (b)(3)(i)(B) of this section) to permit—
(A) Recovery of the significant costs and expenses (including
significant capital expenditures) attributable, under reasonable
principles, to such gross receipts; or
(B) Recovery of such significant costs and expenses computed
under a method that is likely to produce an amount that
approximates, or is greater than, recovery of such significant
costs and expenses.
B-4
APPENDIX C
Treas. Reg. § 1.901-2A (1983). Dual Capacity Taxpayers
(a) Application of separate levy rules as applied to dual capacity taxpayers
(1) In general. . . . . However, if the application of the levy is neither different
by its terms nor different in practice for dual capacity taxpayers from its
application to other persons, or if the only difference is that a lower rate (but
the same base) applies to dual capacity taxpayers, then, in accordance with §
1.901–2(d), such foreign levy as applicable to dual capacity taxpayers and
such levy as applicable to other persons together constitute a single levy. In
such a case, no amount paid (as defined in § 1.901–2(g)(1)) pursuant to such
levy by any such dual capacity taxpayer is considered to be paid in exchange
for a specific economic benefit, and such levy, as applicable in the aggregate
to such dual capacity taxpayers and to such other persons, is analyzed to
determine whether it is an income tax within the meaning of § 1.901–2(a)(1)
or a tax in lieu of an income tax within the meaning of § 1.903–1(a).
Application of a foreign levy to dual capacity taxpayers will be considered to
be different in practice from application of that levy to other persons, even if
no such difference is apparent from the terms of the levy, unless it is
established that application of that levy to dual capacity taxpayers does not
differ in practice from its application to other persons.
(2) Examples. The provisions of paragraph (a)(1) of this section may be
illustrated by the following examples:
Example 1. Under a levy of country X called the country X income tax, every
corporation that does business in country X is required to pay to country X 40
percent of its income from its business in country X. Income for purposes of
the country X income tax is computed by subtracting specified deductions
from the corporation's gross income derived from its business in country X.
The specified deductions include the corporation's expenses attributable to
such gross income and allowances for recovery of the cost of capital
expenditures attributable to such gross income, except that under the terms
of the country X income tax a corporation engaged in the exploitation of
minerals K, L or M in country X is not permitted to recover, currently or in
the future, expenditures it incurs in exploring for those minerals. In practice,
the only corporations that engage in exploitation of the specified minerals in
country X are dual capacity taxpayers. Thus, the application of the country X
income tax to dual capacity taxpayers is different from its application to other
C-1
corporations. The country X income tax as applied to corporations that
engage in the exploitation of minerals K, L or M (dual capacity taxpayers) is,
therefore, a separate levy from the country X income tax as applied to other
corporations. Accordingly, each of (i) the country X income tax as applied to
such dual capacity taxpayers and (ii) the country X income tax as applied to
such other persons, must be analyzed separately to determine whether it is
an income tax within the meaning of § 1.901–2(a)(1) and whether it is a tax
in lieu of an income tax within the meaning of § 1.903–1(a).
Example 2. The facts are the same as in example 1, except that it is
demonstrated that corporations that engage in exploitation of the specified
minerals in country X and that are subject to the levy include both dual
capacity taxpayers and other persons. The country X income tax as applied
to all corporations is, therefore, a single levy. Accordingly, no amount paid
pursuant to the country X income tax by a dual capacity taxpayer is
considered to be paid in exchange for a specific economic benefit; and, if the
country X income tax is an income tax within the meaning of § 1.901–2(a)(1)
or a tax in lieu of an income tax within the meaning of § 1.903–1(a), it will be
so considered in its entirety for all corporations subject to it.
C-2
APPENDIX D
I.R.C. § 903 (2012)
§ 903. Credit for Taxes in Lieu of Income, etc., Taxes
For purposes of this part and of sections 164(a) and 275(a), the term “income, war
profits, and excess profits taxes” shall include a tax paid in lieu of a tax on income,
war profits, or excess profits otherwise generally imposed by any foreign country or
by any possession of the United States.
D-1
APPENDIX E
Treas. Reg. § 1.903-1 (1983). Taxes in Lieu of Income Taxes
(a) In general. Section 903 provides that the term “income, war profits, and excess
profits taxes” shall include a tax paid in lieu of a tax on income, war profits, or
excess profits (“income tax”) otherwise generally imposed by any foreign country.
For purposes of this section and §§ 1.901–2 and 1.901–2A, such a tax is referred to
as a “tax in lieu of an income tax”; and the terms “paid” and “foreign country” are
defined in § 1.901–2(g). A foreign levy (within the meaning of § 1.901–2(g)(3)) is a
tax in lieu of an income tax if and only if—
(1) It is a tax within the meaning of § 1.901–2(a)(2); and
(2) It meets the substitution requirement as set forth in paragraph (b) of this
section.
The foreign country's purpose in imposing the foreign tax (e.g., whether it imposes
the foreign tax because of administrative difficulty in determining the base of the
income tax otherwise generally imposed) is immaterial. It is also immaterial
whether the base of the foreign tax bears any relation to realized net income. The
base of the tax may, for example, be gross income, gross receipts or sales, or the
number of units produced or exported. Determinations of the amount of a tax in lieu
of an income tax that is paid by a person and determinations of the person by whom
such tax is paid are made under § 1.901–2(e) and (f), respectively, substituting the
phrase “tax in lieu of an income tax” for the phrase “income tax” wherever the latter
appears in those sections. Section 1.901–2A contains additional rules applicable to
dual capacity taxpayers (as defined in § 1.901–2(a)(2)(ii)(A)). The rules of this
section are applied independently to each separate levy (within the meaning of §§
1.901–2(d) and 1.901–2A(a)) imposed by the foreign country. Except as otherwise
provided in paragraph (b)(2) of this section, a foreign tax either is or is not a tax in
lieu of an income tax in its entirety for all persons subject to the tax.
(b) Substitution
(1) In general. A foreign tax satisfies the substitution requirement if the tax
in fact operates as a tax imposed in substitution for, and not in addition
to, an income tax or a series of income taxes otherwise generally imposed.
However, not all income derived by persons subject to the foreign tax need
be exempt from the income tax. If, for example, a taxpayer is subject to a
generally imposed income tax except that, pursuant to an agreement with
the foreign country, the taxpayer's income from insurance is subject to a
gross receipts tax and not to the income tax, then the gross receipts tax
meets the substitution requirement notwithstanding the fact that the
taxpayer's income from other activities, such as the operation of a hotel, is
E-1
subject to the generally imposed income tax. A comparison between the
tax burden of this insurance gross receipts tax and the tax burden that
would have obtained under the generally imposed income tax is irrelevant
to this determination.
***
(3) Examples. The provisions of this paragraph (b) may be illustrated by the
following examples:
Example 1. Country X has a tax on realized net income that is generally
imposed except that nonresidents are not subject to that tax.
Nonresidents are subject to a gross income tax on income from country X
that is not attributable to a trade or business carried on in country X. The
gross income tax imposed on nonresidents satisfies the substitution
requirement set forth in this paragraph (b).
E-2